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Modeling electricity spot prices - Combining mean-reversion, spikes and stochastic volatility

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  • Mayer, Klaus
  • Schmid, Thomas
  • Weber, Florian
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    Abstract

    Starting with the liberalization of electricity trading, this market grew rapidly over the last decade. However, while spot and future markets are rather liquid nowadays, option trading is still limited. One of the potential reasons for this is that the spot price process of electricity is still puzzling researchers and practitioners. In this paper, we propose an approach to model spot prices that combines mean-reversion, spikes and stochastic volatility. Thereby we use different mean-reversion rates for 'normal' and 'extreme' (spike) periods. Another feature of the model is its ability to capture correlation structures of electricity price spikes. Furthermore, all model parameters can easily be estimated with help of historical data. Consequently, we argue that this model does not only extend academic literature on electricity spot price modeling, but is also suitable for practical purposes, e.g. as underlying price model for option pricing. --

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    Bibliographic Info

    Paper provided by Center for Entrepreneurial and Financial Studies (CEFS), Technische Universität München in its series CEFS Working Paper Series with number 2011-02.

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    Date of creation: 2011
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    Handle: RePEc:zbw:cefswp:201102

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    Related research

    Keywords: Electricity; Energy markets; Lévy processes; Mean-reversion; Spikes; Stochastic volatility; GARCH;

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    1. Redl, Christian & Haas, Reinhard & Huber, Claus & Böhm, Bernhard, 2009. "Price formation in electricity forward markets and the relevance of systematic forecast errors," Energy Economics, Elsevier, Elsevier, vol. 31(3), pages 356-364, May.
    2. Rafal Weron, 2006. "Modeling and Forecasting Electricity Loads and Prices: A Statistical Approach," HSC Books, Hugo Steinhaus Center, Wroclaw University of Technology, Hugo Steinhaus Center, Wroclaw University of Technology, number hsbook0601.
    3. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, Econometric Society, vol. 59(2), pages 347-70, March.
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